SoFi Technologies, Inc. (SOFI) Earnings Call Transcript & Summary

Good afternoon. My name is Reggie Smith. I cover fintech stocks here at JPMorgan, and I'm pleased and excited to host Anthony Noto, CEO of SoFi this afternoon. Format's going to be fireside chat. We'll start with some questions from me. I will open it up to the floor later on and even checking online for questions as well. With that said, welcome, Anthony, how are you feeling?

So well, thanks for having me, Reggie. Thanks to JPMorgan as well.

Good, good, good. So we'll get right into it. full disclosure, I am a SoFi member. And so I'm intimately familiar with the app and the services. Wanted to start by having you kind of share the SoFi mission for folks. I mean, I think it's helping people get their money right. And that really resonated with me. Maybe give a little background on the company and what you're trying to do and the problem you're trying to solve and for who?

Sure. Happy to. When I joined the company in early 2018, we reestablished the mission and really the strategy overall. And our goal is to help people achieve financial independence to realize their ambitions. And essentially, that means they get to the point that they have enough money to do what they want, buy the house they want, live where they want, size, family, they want it, the career they would like and when they can retire. And in many ways, someone today that's making $100,000 plus really struggles to live the American dream for a variety of different reasons, and they need a relationship bank. They need a bank, financial services company, that can be there for everyday things but also for all the major financial decisions in their lives. If they don't invest in their 20s, they're going to have a hard time catching up and the amount of compounding they need in their 30s and 40s is really challenging. If they overspend on their college education, they're going to be in a hole and they can't invest. If they buy a home that's too big relative to their means they're not going to be able to save and they're going to constantly be running over budget. And so we want to be there for that relationship every day and to be there for all their major things, which means we have to help them borrow better, save better, spend better, protect better and invest better. And we focus on those verbs because that's ultimately what helps them get their money right.

Sounds good. That's great. You guys acquired a bank about a year ago in hindsight, it looks like -- I don't know if it's luck or stroke of genius in that with everything that's going on in the funding market, ABS and wholesale whole loan markets. My question to you, deposit growth has been on a tear of late. What's driving that growth? And how sustainable. Can you talk about the trends that you see in deposits?

A key to our strategy is building a primary relationship with a member so that we can be there and be trusted and be there when they make those decisions. And one way to drive primary relationship is having someone's direct deposit. And so as we started to architect our SoFi Money product, which is a checking and savings account, we thought through all of the needs that someone would have and how to differentiate their products so we could win their direct deposit. It'd be really hard to do that without a bank. So the bank enables us to provide a high interest rate on savings and checking. It allows us to avoid payment fees. We're in control of the value proposition. We enable you technically to pay any when -- anywhere, any way you want. You can pay a friend, you can pay a bill, you can pay via check. You can pay via wire. You can access your money in real time. You can deposit cash from your phone through a partner, you can deposit a check through your phone. And that primary relationship then gives us insights into everything else they're doing to help that person get their money right. So when we launched SoFi Money [indiscernible] the bank license, we launched it with all those characteristics, and it's really helped us drive great direct deposit growth. We delivered $2.7 billion of direct deposits in Q1. And very little of that, if any, was from the fallout that we saw amongst other banks, it's really coming from the largest money center banks, and we continue to see a very strong trend in Q2 as well. We mentioned on the call that we expected to add $2 billion plus per quarter, and we're on track to do that. And the quality of those members is very high with a high FICO score in the 715 range, and it allows us to have 90% of our deposits from direct deposits, and we also offer $2 million of FDIC insurance now, and that's allowed us to have 97% of our deposits that are insured.

That sounds great. Two follow-up questions there. Are you surprised by the success of the deposit program? And then in addition to that, what's your capacity or like how large can that be? Do you have a sense of...

Yes. I would say I'm not surprised by the success of the amount of acquisitions we've had or the deposits. The thing that has been higher than I expected was the percent of the new funded accounts that are direct deposit. It's averaged around 50%. Typically, it's about 35%. So the conversion of funded accounts to direct deposit accounts has been higher than expected. It was a key part of the strategy. We want to build that relationship and be there for the next second and third product. The cross-buying that we're seeing from that customer is very high as well. So it's really worked quite meaningfully. In terms of how we think about size, we really start with the end goal that we think drives shareholder value, which is return on equity and return on invested capital. And we want to drive well past 20% ROE and over 30% ROIC. That's going to be dependent on the mix of businesses that we have and the capital intensity of those and how well we run them. And so the way I think about it is that we have a lot of flexibility in our bank charter. Our bank holding company leverage ratio, equity to assets is 17%. That can go to the low double digits. We have an ample amount of our own equity capital and funding capacity. And so we can continue to grow the member base through checking and savings, which will grow deposits, and we could deploy those deposits efficiently at this point in time. Over time, we may allocate more of the capital to investing or to products outside of checking and savings as an acquisition vehicle into technology partners or launch new businesses. But right now, we have a lot of runway and it's really benefiting us.

Yes, sure. No, that makes sense. I wanted to talk about your personal loan. You guys have become a major player in the personal loan space in the last year or so. What can you tell us about kind of the approval rates, your underwriting posture, APRs, loss expectations. Any insights you can share there? Obviously, investors are very keen and sensitive to that business right now?

Sure. One of our core values is to learn, iterate and innovate. And so we're constantly talking about testing and learning, testing and learning. So even outside of this environment, we are constantly testing pricing and credit to make sure that we're managing our lending within the credit box that we've established, which we haven't changed. We underwrite 680 FICO scores and above. We actually don't underwrite the FICO score. We underwrite the cash flow. And so we're trying to protect the cash flow of that person when we're approving them. Because we're in a premium credit box and a prime customer, we actually decline about 70% of the applicants for our personal loans because if you're below 680, it's a knockout. But then within that box, you still have to have a very attractive credit profile for us on a cash flow and debt perspective. So we only approve about 30% of the people that apply. The other 70% we actually do monetize a portion of them through partners, and it's a great relationship with other underwriters that are in that credit box. We've been able in this environment to pass on the higher cost of interest rates. So we call our coupon, weighted average coupon, and we've been able to pass that on in higher pricing and maintain a great credit profile. We've actually tightened credit. We use a number of factors in deciding what the economic environment is. And we look at macroeconomic indicators as early warning signs. And we've used that to tighten credit throughout the last year, and we're still tightening it now. Our forecast in terms of what we think about the economy and what we factor into our credit models is based on Moody's S3 forecast, which assumes about 5% unemployment in 2024 and about 2.5% of GDP decline. So that's factored into it as well. So still approving around 30%, have tightened credit, have improved quality of credit. Our life of loan losses and annualized losses have been well below our tolerance threshold. So that's been really positive. Last quarter, we reported 2.97%, and we factored in a higher rate than that in our marks. So it's been a great business for us, but we stayed really disciplined.

Got it. Is there -- obviously, you guys have maintained your underwriting standards, but have you seen a share pickup in just applications as other issuers have -- or lenders have pulled back in the market. Anything of note there?

We have gained share, but I would attribute it more towards our ability to have faster time to fund, have attractive pricing and really efficient marketing. We have our time to fund on a personal loan, down to 2 days. When I arrived at SoFi, it was about 7 days. And so when someone wants to borrow money and when they want to do anything with money, they want it to be fast and efficient. So great pricing, great selection. We just added an option that we could do fees to get a lower rate if you'd like to do that. That's all contributed. But the quality stayed really, really high. We're at a FICO score of about 750 and an income of about $160,000.

Got it. Got it. I wanted -- you touched on the loss rates in the portfolio today, I think just about 3%. And I know you guys are planning for something in the 4% range, at least in your fair value assumptions. What -- how should we think about that number trending? I know there are a lot of things going on there. The portfolio was growing and seasoning. But where could that 3% go just to kind of frame that for...

So the 3% is an annualized number on life of loan with durations around 1.5 years. So that would be about 4.5% life of loan loss rate. That's well below our tolerance of 7% to 8%. So when we think about underwriting and we think about valuing the loans and the yield that we can get, if we hold on the loans versus selling them, we think about that 7% to 8% range. That's not what we're currently at, but that's the tolerance that we have. So the credit could be 50% to 70% higher from a life of loan losses before it hits our tolerance. So the credit has been performing really well, and our team has done a great job.

I wanted to move on to accounting. There's been a lot of focus on that lately. You're one of the few banks that use this fair value accounting. Can you explain why that makes sense for SoFi and whether -- or what, if anything, would precipitate a change in your accounting? And then just thinking about getting investors comfortable with the fact that there aren't explicit reserves. Like what do you tell investors on that?

Sure. So on this point, there's -- we have 2 choices when we originate a loan. We can elect fair value or at cost accounting. Our company since before I joined, has used fair value accounting. There's a bunch of reasons for that, but I will tell you, I think it's the best way to account for a balance sheet company that's using loans because those loans have to be mark-to-market. If you do at-cost accounting, you have to take a CECL charge upfront that charge gets adjusted over time based on losses and life-of-loan losses, et cetera. But the balance sheet and income statement do not change based on interest rate impacts or spread impacts and prepayment impacts, et cetera. In fair value accounting, you can choose hold for -- held for sale or held for investment. We've shown held for investment. Under that accounting, under fair value, we mark to market our loans each quarter. We make changes in those zones based on the change in WACC, the change in interest rate, the change in spread, the change in prepayments. Every factor that could change its value, we have to recognize it real-time, and it flows through our income statement and our balance sheet. At cost accounting, companies could report an equity balance that's positive $18 billion on a Monday and a week later, actually be taken into a receivership because they don't record the unrealized loss in their balance sheet or their income statement, and it's not as transparent. Fair value accounting is much more transparent and it actually marks-to-market those underlying assets. And so that's what we use. In terms of any changes, once we elect fair value accounting, there's no way the accounting on those loans are going to change. You can't change from fair value accounting to cost accounting on a loan once you've elected for value accounting. Similarly, if you go from held for sale to held for investment, the accounting also won't change if it's under fair value. It will change the designation of the balance sheet from held for sale under fair value held for sale to fair value held for investment, but the actual accounting would not change in its under fair value. In terms of losses, I think this is probably the most misunderstood thing. When we mark a loan based on held for sale on our books, it actually is assuming a loss for that loan and then it actualizes over time. And so when we talk about a 2.97% loss rate and the loans at the end of Q1, when we marked our loans at the end of Q1, we actually assumed a higher loss rate going forward than at 2.97%. In fact, we've actually assumed about 4.5% to 4.6% based on the outlook investors have for losses in the economy. So there is an allocation for loss in the mark. More importantly, once a loan goes 10-day delinquent, we write it down by 35% through the income statement and balance sheet. Once it goes 30-days delinquent, another 35% on the original amount. So after 30 days delinquent, we've written that loan down by 70%. At 90 days, it's written down by 90% and then 120 days, it's written off completely. And so not only are we taking a loss assumption in the mark, we're actualizing it based on the delinquencies as they happen over time.

Understood. And so if I'm hearing you correctly, what we should be focused on and super sensitive to would be the delinquency rate that's coming through the portfolio? Is there some kind of a trend that we should be tracking as investors?

I would say you really want to track all of the things I've mentioned. And the reason why I say that is if you think about interest rates, they've had a more pronounced impact on the value of loans on a balance sheet than any other factor in the last year. And because we do fair value accounting, and therefore, mark-to-market, if we did not hedge our interest rates on our balance sheet, we'll be taking big hits on interest rates going higher against our fixed rate loans. But we do hedge our loans, and so that hasn't happened. So I wouldn't point you to any one of those metrics, I would point you to totality of them because that's what impacts the value of the loans each quarter. And we've actually marked a monthly internally than externally, reported on a quarterly basis.

Understand. And just a quick point of clarification. I think you said they are classified as held for investment. Did you mean held for sale?

Yes, I meant held of sale, sorry. So fair value held for sale is the way we've classified those. We do have the ability to go from fair value held for sale to held for investment, but it wouldn't change the accounting.

Got it. Speaking of sales, I got to ask you, a lot of focus recently on the fact that you've not been selling loans. What do you tell investors about that?

Yes. The first thing that we say when we're asked about holding versus selling and investing in any of our businesses that we're really focused on optimizing our return on equity and return on invested capital. And so when we have a choice to sell a loan at 104% or hold it at 106%, we're thinking about what is the ROE. And again, we have to also factor in where are we in our leverage ratio, where are we in our ability to fund loans and making sure we have the right balance sheet risk management. As long as we have the leverage ratio, that 17% versus being in the low double digits, we have capacity to continue to fund. We have $3 billion of equity, $8 billion of warehouse lines, $5 billion of it is unused at the end of Q1. And in addition to that, we have $10 billion of deposits. If we have room on the balance sheet, we have liquidity, we have funding capacity. We have the option to choose the best yield or best return. And so more recently, we believe we can get about a 6% return on assets by holding the loans versus selling them at a 4% return on assets. And if you think about that on an ROE perspective, that's about a 43% ROE if we held, versus a high 20% if we sold. And so that's what's driving the decision. We've been in periods like this in the past, where we're in a rising interest rate environment, followed by a declining [ industry ] environment, where we've made the same decision. If you go back to 2018, Fed was raising rates throughout the year. We were doing asset-backed securities deals then. The bids we were getting for residuals weren't attractive to us relative to holding them. We chose to hold those residuals during that time, get to 2019 at the end of Q1. Fed's no longer are raising rates. People thought they would be raised 4 or 5x in '19, didn't happen. All of a sudden, the bids for those residuals became stronger than holding those resids and we sold them. So as long as we have the flexibility, we're going to pick the best return for the company. There could be times when we don't have that flexibility, but we don't see that in the near future given how much capacity we have to fund the liquidity we have and where our leverage ratio is.